DBRS Confirms Republic of Slovenia at A, Trend Changed to Positive

DBRS Ratings Limited (DBRS) confirmed the Republic of Slovenia’s Long-Term Foreign and Local Currency – Issuer Ratings at A. At the same time, DBRS confirmed the Republic of Slovenia’s Short-Term Foreign and Local Currency – Issuer Ratings at R-1 (low). The trend on all ratings has changed to Positive.

KEY RATING CONSIDERATIONS

The Positive trend reflects DBRS’s view that credit quality across many analytical building blocks is improving. Impressive economic growth in recent years has helped repair fiscal accounts and accelerated the downward trajectory in the debt-to-GDP ratio. DBRS expects healthy fiscal surpluses in the coming years and general government debt to decline to under 62% of GDP in 2020. If completed, that debt consolidation would constitute a remarkable reduction of over 20 percentage points of GDP since 2015. Current assumptions point to a debt ratio below the 60% Maastricht threshold by 2021. Slovenia’s credit strengths stem from its wealthy and high value-added economy compared to A category regional peers, its effective debt management and judicious fiscal framework, and its membership of European institutions.

Despite these strengths, the ratings are principally constrained by the small and open nature of the Slovenian economy that makes it vulnerable to external shocks, and the country’s still high stock of public sector debt. Notwithstanding the noteworthy reduction, government debt remains above regional peers. Long-run debt reduction could be challenged by rising age-related spending. Unfavourable demographic trends are expected to place structural pressure over the long-term on public expenditures in the absence of healthcare and pension reform.

RATING DRIVERS

Ratings could be upgraded if the government’s debt ratio declines in line with DBRS expectations – driven by sustained economic growth and prudent fiscal management. The passage of policy measures that strengthen medium-term growth prospects without generating large macroeconomic imbalances could also trigger an upgrade.

Although DBRS sees risks to the ratings as tilted toward the upside, the ratings could face downward pressure if the improving trend on debt dynamics reverses due to a shock to Slovenia’s small and open economy that causes significant economic underperformance, material fiscal slippage, or substantial realization of contingent liabilities.

RATING RATIONALE

Slovenia’s Strong Performance on Fiscal and Debt Metrics is a Positive Credit Feature

Fiscal consolidation in recent years has been significant due to favourable economic conditions, strong revenue growth, and a steady decline in interest expenditure. Following a 5.5% of GDP deficit result in 2014, the fiscal balance reached a 0.7% surplus in 2018. Under current assumptions, the EC expects a similar fiscal surplus in 2019 from last year and a slight improvement in the surplus to 0.9% in 2020. The main downside risks to public finances stem from weaker revenue intake in an economic downturn and high expenditure growth, predominantly in wages and social benefits. Given Slovenia’s weak demographic outlook, the age-related costs are expected to increase and will likely weigh on Slovenia’s structural fiscal performance. Any additional progress made on healthcare and pension reform would support the long-term sustainability of public finances. The EC’s forecasted structural deficit of 0.3% of potential GDP by 2020 is nonetheless manageable, in DBRS’s view.

Improved fiscal and economic conditions and a comfortable funding profile have placed debt as a share of GDP on a firm downward path. Since 2015, when it reached its peak at 82.6%, the debt to GDP ratio declined by 12.5 percentage points to 70.1% in 2018. Current forecasts point to continued aggressive debt reduction through the end of the decade, falling below the 60% of GDP threshold by 2021. As stipulated by law, 90% of proceeds from the privatisations of Nova Ljubljanska Banka (NLB) and Abanka, expected to reach €1.1 billion once completed, will also be directed towards debt reduction. Nevertheless, the public debt burden is high when compared against regional peers of similar economic size. The high debt stock limits shock absorption capacity and redirects public funds towards debt servicing. The debt-stock increase caused interest costs to rise from 1.1% of GDP in 2008 to a peak of 3.2% in 2014 and 2015. Low bond yields have since caused the interest bill to decline to 2.0% in 2018 and is expected to fall to 1.6% in 2019.

Domestic Conditions Support Slovenia’s Impressive Economic Growth Performance

Slovenia’s recent economic performance has been remarkable. Following 4.9% growth in 2017, real GDP growth reached 4.5% in 2018, underpinned by sturdy domestic demand and strong albeit decelerating export growth. The steady resurgence of investment since 2017, from improved private sector balance sheets and the delivery of EU structural funds, is also a main contributor to GDP growth results. Sustained wage and employment gains and growing household disposable incomes, in a context of contained inflationary pressure, have also led to upbeat consumer confidence. The EC expects growth to average 3.0% in 2019-20, in line with measures of growth potential. The government’s calculation of output potential has increased from 2.3% in 2018 to 2.9% in 2019.

Slovenia’s competitive external sector supports its strong current account surplus. Slovenia is integrated into the regional supply chain and manufactures a diverse range of high value-added component parts. Improved cost competitiveness and a strong pick-up in external demand in recent years contributed to a steady rise in trade volumes. Even though export growth has recently expanded at a slower pace due to the slowdown among Slovenia’s main trading partners, the 2018 current account surplus of 5.6% of GDP, according to the Bank of Slovenia, is strong. DBRS expects such a strong external savings position to continue to narrow the net international investment position (IIP). Latest data show IIP improved to -17.7% of GDP as of March 2019, from -44.2% in 2012.

Improved Financial Sector Indicators and Progress on Privatisations

The banking sector has worked through its crisis-legacies and is in repair. In the context of strong economic performance, credit growth has returned to positive in the non-financial private sector. Loans to households have been particularly strong. Recent Bank of Slovenia stress testing find the banking system to be stable. Banking sector resilience is evident by improved capital and funding positions and the improvement in asset quality. Non-performing loans (NPL), mostly legacy loans concentrated in the real estate and construction sectors are on a healthy declining trend. The NPL ratio, measured as claims with arrears over 90 days to total claims, declined from 18.1% in November 2013 to 2.0% as of May 2019. After expanding by over 10% in early 2018, real estate price growth in Slovenia has slowed down but continues to expand above nominal GDP growth. Given the limited supply of housing and the high demand for it, DBRS expects price pressure to continue. Despite the upward trend in house prices, comfortable private sector debt ratios and macroprudential measures appear to mitigate risks.

The completed sale of NLB and the expected sale of Abanka are important achievements. The government relinquished 65% of the largest bank NLB following an IPO in late 2018 and another 10% in June 2019. Previously privatised bank Nova KBM (NKBM) is committed to purchase Abanka, the third largest bank. That transaction is pending approval and is expected to close by the end of 2019. The divestment of these banks is an important step in the government’s efforts to reduce the historically high direct involvement of the state in the economy and reduces the government’s exposure to potential calls for capital to support these banks.

Notwithstanding the 5-Party Coalition Government, Slovenia has Stable Policy-Making Institutions

Prime Minister (PM) Marjan Sarec formed a government in September 2018. Despite winning the largest share of votes with 25%, Janez Jansa of the Slovenia Democratic Party was unable to form a government. This allowed Sarec to form a 5-party minority coalition government. The fragmented nature of the new administration complicates the reform agenda and does not preclude another early election.

Despite the political volatility, Slovenia has strong institutions. The country benefits from its membership of both the EU and Euro area, which functions as a stability anchor for macroeconomic policy. Slovenia also benefits from a healthy inflow of EU structural fund investments directed towards productive areas. The country’s credible policy framework is underpinned by its strong performance on the World Bank’s Governance Indicators when compared with its peers, particularly the Rule of Law and Government Effectiveness. The main policy challenge facing the next few governments will be how it manages the fiscal and economic consequences of its aging population.

RATING COMMITTEE SUMMARY

The DBRS Sovereign Scorecard generates a result in the AA (low) to A range. The main points discussed during the Rating Committee include the outlook for fiscal policy, bank privatizations, economic performance, and debt management.

KEY INDICATORS

Fiscal Balance (% GDP): 0.7 (2018); 0.7 (2019F); 0.9 (2020F)
Gross Debt (% GDP): 70.1 (2018); 65.4 (2019F); 61.7 (2020F)
Nominal GDP (EUR billions): 45.9 (2018); 48.5 (2019F); 51.3 (2020F)
GDP per Capita (EUR): 22,182 (2018); 23,391 (2019F); 24,714 (2020F)
Real GDP growth (%): 4.5 (2018); 3.1 (2019F); 2.8 (2020F)
Consumer Price Inflation (%): 1.9 (2018); 1.8 (2019F); 2.1 (2020F)
Domestic Credit (% GDP): 119.7 (2018); 118.6 (Mar-2019)
Current Account (% GDP): 5.6 (2018); 6.7 (2019F); 6.1 (2020F)
International Investment Position (% GDP): -18.9 (2018); -17.7 (Mar-2019)
Gross External Debt (% GDP): 91.6 (2018); 87.0 (Mar-2019)
Governance Indicator (percentile rank): 82.4 (2016); 82.4 (2017)
Human Development Index: 0.89 (2016); 0.90 (2017)

EURO AREA RISK CATEGORY: LOW

Notes:

All figures are in euros (EUR) unless otherwise noted. Public finance statistics reported on a general government basis unless specified. The fiscal balance and gross debt projections (European Commission). Nominal GDP (Statistical Office of the Republic of Slovenia/European Commission), GDP Per Capita (Statistical Office of the Republic of Slovenia/European Commission), Real GDP Growth (Statistical Office of the Republic of Slovenia/European Commission), Inflation (Statistical Office of the Republic of Slovenia/European Commission), Domestic Credit (BoS), Current Account (2018 BoS/ 2019 and 2020 European Commission), International Investment Position (Bank of Slovenia), Governance indicator represents an average percentile rank (0-100) from Rule of Law, Voice and Accountability and Government Effectiveness indicators (all World Bank). Human Development Index (UNDP) ranges from 0-1, with 1 representing a very high level of human development.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website www.dbrs.com at http://www.dbrs.com/about/methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website at http://www.dbrs.com/ratingPolicies/list/name/rating+scales.

The sources of information used for this rating include the Ministry of Finance, Bank of Slovenia, Institute of Macroeconomic Analysis and Development, European Commission, Statistical Office of the European Communities, OECD, IMF, World Bank, UNDP, Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

This is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance.

For further information on DBRS historical default rates published by the European Securities and Markets Authority (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

Ratings assigned by DBRS Ratings Limited are subject to EU and US regulations only.

Lead Analyst: Jason Graffam, Vice President, Global Sovereign Ratings
Rating Committee Chair: Roger Lister, Managing Director, Chief Credit Officer, Global FIG and Sovereign Ratings
Initial Rating Date: November 17, 2017
Last Rating Date: March 1, 2019

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